Emergency money is not investment money. It has a few characteristics that investment money does not: It must be easily available on a few hours notice. It can be accessed from almost anywhere. It does not shrink in amount because something negative happened in the market or the economy. Investment money is money you do not foresee needing. It generally takes at least three days for securities sale proceeds to appear as cash in your account, and several more days to transfer that money to your checking account at a local bank.
Short-Term Bond Funds
Short-term bond funds are made up of bonds that have maturities out to two years, and sometimes out to five years. The liquidation value of short-term bond funds fluctuates with the bond market. Interest rates can move drastically and rapidly with changes in Federal Reserve policy and economic events. Although short-term bond prices are relatively stable compared to long-term bonds, and short-term bonds may yield more than money market instruments, they are only appropriate for a portion of your emergency funds. The value of short-term bond funds may be lower than you expect at the time you need the money and they may not have same-day settlement, which means you must wait two or three days to use your money.
Money Market Funds
Money market funds are not the same as short-term bond funds. They are made up of certificates of deposit, bankers' acceptances, commercial paper, Treasury bills and Treasury bonds that have less than one year until maturity. They are designed to be cash-equivalent investments, meaning the money in them is accessible the same day. Many money market funds have checking accounts attached to them so you can access your money immediately.
Keep a large portion of your emergency money in savings accounts where the money may be accessed immediately. Certificates of deposit can also be cashed in for immediate access to your money, but doing so sometimes carries penalties for early withdrawal. Longer-term CDs, particularly, can have significant interest penalties, but withdrawal penalties on CDs only affects the interest. You should be able to withdraw your principal at any time. Different banks may have different policies, so ask before you deposit your emergency funds in a CD. The main value of keeping your emergency money in a bank is its easy availability. If you need to withdraw a large amount of cash, use your debit card or write a check, bank accounts and some money market accounts are the best places to store your funds. Short-term bond funds, even if they are purchased through your bank, are not cash-equivalent investment vehicles.
Many advisers suggest keeping six months of living expenses as emergency money. It is unlikely you will need such a large sum to meet most emergencies, so you may be able to keep a portion of your emergency money in short-term bond funds to take advantage of the higher yield. Emergencies requiring quick cash usually can be covered with under $1,000 in cash. Bailing your car out of impound after it has been towed, for example, will require much less money. By contrast, if your roof blows off in a storm, and you must pay the full price of repair up front to have it quickly replaced, you may need $10,000 ready cash.
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